Germany is approaching a recession at the end of 2023, but faces a long-term recession

Europe's largest economy contracted by 0.3% year-on-year in 2023, as higher inflation and fixed interest rates weighed on growth, Germany's Federal Statistics Office said on Monday.

This estimate is in line with the expectations of analysts polled by Reuters. The decline in economic output narrowed to 0.1% when adjusted for evaluation purposes.

“Germany’s overall economic development stalled in 2023 in an environment still plagued by crises,” Ruth Brand, head of the Federal Statistical Office, said, according to a Google translation.

“Despite the recent declines, prices remained high at all levels of the economy. Added to this are unfavorable financing conditions due to high interest rates and low demand from home and abroad,” Brand added.

Germany's inflation rate rose by 3.8% year-on-year in December on a coordinated basis, the statistics office reported. He said on January 4. The European Central Bank in December chose to keep interest rates unchanged for the second time in a row, shifting its inflation forecast from “expected to remain very high for a very long time” to expectations that it will “gradually decline over the next year.”

Germany's manufacturing sector, excluding construction, fell by a sharp 2%, led by lower output in the energy supply sector. Weak domestic demand last year and “weak global economic dynamics” also stifled foreign trade, despite falling prices. Imports fell by 1.8%, a sharper decline than exports and resulting in a positive trade balance.

Household consumption contracted by 0.8% year-on-year, after adjusting for prices, while government expenditures fell by 1.7%.

The fourth quarter recorded a similar decline of 0.3% compared to the July-September period. The German economy experienced a recession in the third quarter, the office said, meaning the country narrowly avoided a technical recession defined by two consecutive quarters of consecutive declines in gross domestic product.

A German Economy Ministry report released on Monday warned that early indicators do not point to a rapid economic recovery in Germany.

Capital Economics also expects that Germany's problems are far from over, and expects no growth for the country in 2024.

“The recessionary conditions that have persisted since the end of 2022 look set to persist this year,” Chief European Economist Andrew Kenningham said in a note. “Admittedly, the recent decline in inflation should provide some relief to households, but residential and business investment is likely to contract, construction is heading into a sharp contraction, and the government is tightening fiscal policy sharply. We expect zero GDP growth in 2024 “.

The sobriquet “Sick Man of Europe” has haunted Germany for much of the past year, even as it has overcome the shocks of losing access to some of Russia's sanctioned energy supplies in the wake of Moscow's invasion of Ukraine. Analysts expected Germany to be the only major European economy to contract last year.

The German economy faced the throes of a deep budget crisis at the end of last year, after a Constitutional Court ruling on national borrowing restrictions threatened a 17 billion euro gap in the country's spending plans for 2024.

The German constitution stipulates that the national debt brake limits the federal deficit to no more than 0.35% of GDP outside of emergencies, and has become a major bone of contention in national politics in the past year. The German government agreed to suspend the borrowing cap, after the Constitutional Court blocked attempts to repurpose any remaining emergency funds initially allocated to tackle the Covid-19 pandemic.

Weeks of negotiations have resulted in a budget deal that keeps debt restrictions in place until 2024, with the government expecting to save 17 billion euros ($18.6 billion) in its core budget by ending climate-harming subsidies and implementing cost cuts, according to German Chancellor Olaf Scholz's three-year plan. The alliance was announced in mid-December.